Earlier this year, I made the mistake of buying Codan shares. In my article on why I bought Codan shares, I wrote:
“Today, Codan is basically priced for decline. In the most recent half, it generated a profit of about 27 cents per share. On the conference call, the company said that it is not expecting much of a skew to the second half, implying that it would be a surprise to make more than about $100m profit, for the full year. More likely, we’ll see something like $90m profit for the full year, with the run rate closer to $40m per half. In that case, we might forecast $80m profit for FY 2023, assuming no growth. That would be at about 44c per share.
This is massively at odds with the 62c per share in FY 2023 consensus analyst estimates. I do not know why the analysts are all so bullish, but the lowest estimate is 59c per share. Either way, the market is not on the same wavelength because the share price is about $7, or just 11.8x the lowest analyst estimate for FY 2023.
Using a more conservative 44c per share, and penalsing Codan a bit for its debt riddled balance sheet, I think Codan is trading on about 16 to 17 times conservative earnings per share, or an earnings yield of about 5.8%. Since “the board expects to continue its policy of paying shareholders in the order of 50% of our full year profits as dividends”, I can expect a dividend of around 2.9% based on my conservative estimated earnings.“
Clearly, then, I thought that the analyst consensus estimates were too high. Furthermore, I mentioned in my article that I thought there were risks in Africa, particularly with the instability in Sudan. However, it turns out profits will be lower than I had thought.
My concerns about Sudan were somewhat allayed after watching Codan CEO address members of Strawman, and I believe the company has badly underestimated the problems there. In that Strawman session, the Codan CEO talked about potential growth in Africa, in years to come, and even said “We have pricing power, we can increase prices in the market, from a Minelab perspective.”
At 38 minutes in the video, asked about conflict in Sudan and sovereign risk, Codan CEO Alf Ianiello played down the impact of the recent coup. He said, “a geopolitical risk can be an opportunity or a risk… even with a coup, there’s a lot of coups that occur in Africa have no impact to our revenue, but Sudan did have a dent, but there were other issues apart from the coup in Sudan that impacted sales; you had high energy costs, probably some tailwinds from the year before with covid, then you had some import tax issues that also impacted that…”
However, today in the AGM update, the company says:
“Sudan, our single largest market in Africa has been materially impacted by a military coup. The previous democratically-elected government actively encouraged artisanal gold mining as a means of driving employment and building wealth within regional communities. Now, under military rule, some gold mining regions are being controlled by military forces and remain off limits to artisanal miners. This was a key reason for the reduction of our sales in FY22 and this market has further declined in FY23 along with broader weakness seen throughout Africa.“
Codan’s Financial Deterioration
On top of that, today’s announcement outlines a significant deterioration to Codan’s financial situation.
First of all, profits in H1 FY 2023 are expected to be $25 million to $30 million. If the low end of this range is achieved, and if it is then repeated in the second half, Codan’s full year profit would drop roughly 50%. In that scenario it would make $50m in profits in FY 2023. At the current share price of $4, Codan’s market cap is about $710 million, and it is expected to have net debt of about $70m at the end of December. If debt reduced slightly, Codan might have an enterprise value of around $750m at a share price of $4. With $50m of profits, it would be on around 15x earnings.
This price of 15x earnings would not be outrageously expensive, but nor would it be cheap.
However, the real issue with this update is that the company said that a the end of December 2022 it would have net debt of around $70m. At the end of the last half, Codan boasted improved cashflow, and net debt of just $30m. My optimism on the story was completely dependent on the idea that the company was returning to its prior track record of generating significant free cash flow.
Why I Plan To Sell My Codan Shares
While this profit result is disappointing, I expect Codan’s profits to be a bit lumpy. Given the share price fall, I would not argue that the company is overvalued based on profitability. However, for the reasons described above, particularly the terrible cash flow management, I have completely lost trust in Codan management.
My view is that they have massively misjudged the situation and that the current CEO, who has been in the role for 10 months, should take responsibility for that. In August, the company merely warned that Minelab sales “may not reach the level achieved in FY22 in H1 FY 2023”, but today we learned that Minelab sales will in fact be as low as 55% of the prior corresponding period.
I find the use of the word “may” in the prior guidance, implying there was some prospect of sales growth, to be particularly pernicious. I do not understand how the company could go from “maybe some growth, maybe not” in August 2022, to -45% decline just 2 months later. As a result of this, I no longer have confidence in Codan and I do not wish to hold shares in the company.
This is a painful loss for me and it is squarely my fault for not realising how bad the situation if Africa was. Clearly, this was a known issue, and I was wrong to underestimate. I am sorry.
As a result of all this, I will look to sell my shares in Codan, any time from tomorrow. I will likely do it over a number of transactions.
Please remember that these are personal reflections about stocks by an author, and this article is not intended as a recommendation. The author owns shares in Codan and plans to start selling them the day after publishing this article. This article is not intended to form the basis of an investment decision. It is an investment diary valuable only for the cognitive process it demonstrates. Any statements that are advice under are general advice only. The author has not considered your investment objectives. Any statements that are advice are authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).
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